For empirical analysis, we consider quotes for derivatives on the Halifax HPI, a transaction-based hedonic index reflecting monthly quality adjusted house price development in the UK. In contrast to appraisal based indexes such as the often referenced IPD indexes, a transaction based index does not suffer smoothing effects that distort derivative prices. Smoothing effects of appraisal-based property indexes are described in Geltner, MacGregor, and Schwann (2003).
The Halifax HPI derivatives market provides daily liquidity. The nonseasonally adjusted all buyers monthly index is the reference instrument of the Halifax HPI family. Daily bid and ask quotes are from the brokerage firm Tradition Financial Services (TFS) for Halifax HPI forward contracts with maturities from one to thirty years, from February 2007 to August 2008. Even though the market for property derivatives is very young, their prices experienced strong fluctuations. Fig. 3 displays all observed forward prices against their maturities. The highest levels were reached in May 2007, the lowest in July 2008.
[Insert Fig. 3 about here]
Only contracts with maturities up to ten years are traded regularly and are quoted at reasonably narrow bid-ask spreads. We concentrate on the data of these contracts to avoid data not updated for several days or weeks.
The data set allows assessing the market implied cost of the frictions that impact derivative prices. First, we calculate the property spreads from the forward prices according to Eq. (2). We again use LIBOR and swap rates as well as a 5% rental rate as described above. The resulting property spreads are shown in Fig. 4.
[Insert Fig. 4 about here]
Furthermore, we estimate the parameter
using historical index values. To get a reasonable result,
we include one full market cycle. As of July 2008, the market is 11 months after the most recent peak of house prices. Going back a full market cycle, we find June 1990 as the corresponding point in time 11 months after the market peaked last time in July 1989. For this period, monthly index values for the
Halifax HPI as well as 1-month LIBOR rates are obtained.
Using this monthly data, the parameter
is 3.98% p.a. according to the criterion in Eq. (11). Next, consider the values of the market frictions. The transaction costs k1b
can be observed
exogenously as they reflect cash out costs. There is survey evidence on the magnitude of transaction